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There seems to be a disconnect between the economic news and market action. Specifically, the action of the Spanish IBEX 35 Index, today up 2.09%, and the Italian FTSE MIB Index up 1.08% seems to contradict economic reports released earlier this week. GDP reports showed that both Spain and Italy were in recessions with two quarters of negative numbers. Italy had a 0.7% contraction and Spain a .4% reduction in the most recent quarter. Unemployment in Italy was 10.8%, while Spanish unemployment at 24.8% is even higher than the 22.5% in Greece.

There have been comments made by the Spanish PM that some ECU money will be coming to refinance one of the troubled zombi banks. If money is coming to Spain, then Italy cannot be far behind, right? The trouble here is that while Spain and Italy are too big to fail, they are also way too big to be rescued. Could it be that Rajoy is setting the stage for a rejection by Merkel, thereby facilitating an early exit from the euro? More likely the markets are just enamoured with the idea that the euro supply is going to grow.

Contrast this to the US where the economic news is mostly positive. Wednesday, the retail sales number came in much better than expected up 0.8% after several months of lower numbers. There are those who doubt the economy is this strong, and the positive number is bloated by ‘seasonal adjustments’. Yesterday, while the Philadelphia survey of manufacturers was negative, the Initial Jobless claims were about as expected, and there was a surge in new US Building Permits.

Initially the USD firmed, as the economic news was thought to be good enough to deter Fed Chairman Bernanke from initiating QE 3. In yesterday’s choppy, late summer trade, the USD has since reversed.

While the trade in the EURUSD has recently been trend less, the USD and other currencies are gaining versus the Japanese yen. Earlier this week it was reported the Japanese growth in the last quarter faltered to a negative 0.3, much less than expected. This puts the annualized GDP estimate down to a positive 1.4%, far less than the previous year’s 5.5%.

Wednesday’s US Net Long Term TIC Flows showed the Japanese were continuing to invest in US Treasuries. According to Bloomberg:

“Investors in Japan bought $10.4 billion of Treasuries in June, bringing their purchases for 2012 to $61.3 billion and total holdings of the debt to $1.1193 trillion, Treasury data released yesterday show.

That compares with China’s addition of $300 million to its portfolio of U.S. government securities for the month, raising its purchases this year to $12.4 billion and its stake in Treasuries to $1.1643 trillion. Should both countries continue buying at their respective paces through 2012, Japan will end the year with more Treasuries.”

The yield spread between US and Japanese notes and bonds make the US paper attractive. Five-year notes in the US yield .80, and the ten-year is now up to 1.81. Contrast this to rates of .24 for the 5, and .86 for the Japanese 10-year bonds. Historically, the yen is very strong versus the USD, which adds to the US Treasuries appeal. In 2010 it traded well above 90, and in 2007, a USD fetched over 120 yen.

Looking at the daily chart of the USDJPY, the pair has spent the last month making a saucer bottom, and may be breaking out to the upside. The down trend line has been broken. A count after breaking the side of the saucer would take the USD back up to about 80.80. The Bank of Japan and the Japanese exporters want a cheaper yen. It looks like they may get it.